US: A new peak for household debt – Westpac

As per the Q1 2017 Household Debt and Credit Report from the NY Federal Reserve, household debt reached a new historic peak at March 2017 of $12.73trn, $50bn above the prior high of September 2008, notes Elliot Clarke, Research Analyst at Westpac.

Key Quotes

“However, the structure of household debt is different in 2017 versus the prior peak. Mortgage debt remains 7% lower than Septemebr 2008, and home equity loan balances are 34% lower – both are a legacy of the housing-focused post-GFC deleveraging and the strong lending standards that have remained in place ever since. The stock of credit card debt is also 11% lower.”

“There are a number of aspects of the household debt stock that are worthy of investigation. Below we focus on two: its sustainability relative to household income; and the heterogenous lending standards that are in force.”

“While the stock of household debt reached a new high in early- 2017 in dollar terms, relative to disposable income it is actually at a cycle low. From a peak of 124% at end-2007, household debt as a share of disposable income has fallen to 95%. That is the lowest level since mid-2002. As such, US households currently have a healthy capacity to meet their loan obligations and to pay down their liabilities through time.”

“An additional point to note on serviceability is one we have made often in 2017. That is, despite four hikes (100bps in total) having been delivered to date in this rate-hike cycle, the 30-year mortgage rate is only 46bps above its historic low, which came in late-2016. US households arguably have both the capacity and incentive to take on additional debt while interest rates remain so low – this is particularly true for mortgage debt given the interest rate can be fixed at this historically-low level for 30 years.”

“Also important to consider is the credit quality of new mortgages and other forms of debt. Here there is a significant disparity. As per the NY Federal Reserve’s report, almost 60% of new mortgages over the past year have been to ‘super-prime’ borrowers, with a further 33% being to ‘prime’ borrowers. Just 7% of the flow of new mortgage credit has therefore been to ‘sub-prime’ applicants. Ever since the GFC, this strong skew toward high credit score borrowers has remained in place. It is unsurprising then that mortgage and home-equity default rates are at low levels relative to the past decade.”

“In stark contrast to mortgages are auto loans. The NY Federal Reserve reports that auto loan origination has been equally split across ‘super-prime’; ‘prime’; and ‘sub-prime’ borrowers. This split is not materially different from history; but in a rising interest rate environment, and given many lower-income households are likely to be facing significant cost of living increases, debt incured for discretionary consumption can become a material burden. Note that this category’s delinquency rate has been (slowly) trending higher since 2013, in contrast to mortgages and student loans.”

“For student loans, credit score distributions are not an appropriate benchmark because borrowers are typically young and have little prior experience with credit to base a score on. However, combined together the rate of growth in this category of debt; the interest rates charged; the inability of the debt to be easily discharged in bankruptcy; and the historically elevated delinquency rate cannot be underestimated as a risk to consumption and the US economy, should a downturn eventuate.”